Treasury market's Fed fears confirmed

Prices fall sharply after Greenspan downplays weak data

KateGibson

CHICAGO (CBS.MW) -- Treasury prices thudded sharply lower Tuesday after Alan Greenspan opened the door to further interest-rate hikes, saying borrowers and lenders alike are ready for the Fed moves.

The benchmark 10-year note used in setting mortgage and corporate lending rates ended off 22/32 at 102 13/32, with its yield
TNX, +3.23%
climbing to 4.45 percent from 4.36 percent at Monday's close.

Market watchers said some investors were taken off-guard by Greenspan's turning aside recent indicators of a potentially slowing economy.

"Bond market players have been throwing around theories about a second half slowdown, with the June data creating a huge stir, but the Fed has almost not given that idea a second thought," said Steve Stanley, an analyst with Greenwich Capital Markets.

"What would 'pain' bonds is if he (Greenspan) indicates the recent slowing in the economy, like inflation, is transitory," said Maryann Hurley, an analyst with D.A. Davidson & Co.

The prediction proved on target, with the market skidding rapidly lower after the Federal Reserve chairman downplayed recent thinking by some of a slowing economy, as well as thoughts that inflation might be spiraling out of the Fed's control.

"The evident strengthening in demand that underlies this improved performance doubtless has been a factor contributing to the rise in inflation this year. But inflation also seems to have been boosted by transitory factors such as the surge in energy prices," Greenspan said in his prepared text. Read the full story.

"Greenspan's statement that rates may have to rise more rapidly than the gradual pace that is currently in effect was something of a surprise," said analysts at Action Economics.

The Fed head essentially said he and his colleagues are "not scared of having to raise rates more rapidly if we have to," said Ian Shepherdson, chief economist at High Frequency Economics.

Greenspan's testimony came as the market neared the end of a second session spent on the defensive, with bond investors overlooking an unexpected drop in U.S. housing starts early on to fixate on Greenspan's congressional testimony in the afternoon.

No home detours

The government Tuesday morning reported an unexpected drop in new home construction in June, with analysts divided on whether the lowest count so far this year represents a blip or indicates the beginnings of a trend.

The Commerce Department estimated new home starts fell 8.5 percent from May to a seasonally adjusted annual rate of 1.802 million, below forecasts of 1.97 million. Building permits, an indicator of coming construction, fell 8.2 percent to 1.924 million.

The government data "suggest that slightly higher mortgage rates and a lot of rain in the South had an impact," said Kevin Giddis, managing director, fixed income, Morgan Keegan & Co. But Giddis added that it remains to be seen whether "this is temporary and weather-related or the beginning of a slowing trend."

The report indicates that the construction sector is "not only moderating its contribution to economic growth, but (is) now subtracting from it," Mat Johnson, an analyst with ThinkEquity Partners, said in offering a more definitive view.

Others, however, did not agree.

"Higher mortgage rates will eventually induce a real slowdown in the housing market, but this drop in starts is not evidence of that slowdown," said Shepherdson. "Mortgage demand is still running at very high levels, so sales and starts are still well supported," he said.

Regardless of the report's implications, the figures barely registered in the bond market, with Tuesday's activity pegged to Greenspan's session before lawmakers.

"If history is any guide, Greenspan's semi-annual report to Congress will have a large bearing on the Treasury market for weeks to come," said Tony Crescenzi, chief bond market strategist for Miller Tabak & Co.

Greenspan, who began his address before the Senate Banking Committee at 2:30 p.m. Eastern, will return Wednesday for an appearance before the House Financial Services Committee.

At the short-end, the 2-year note ended down 7/32 at 100 7/32, its yield at 2.63 percent versus 2.53 percent at the prior session. The 5-year note fell 15/32 to 99 26/32, its yield raised to 3.67 percent, compared to 3.56.

The 30-year bond fell 1 1/32 to 102 24/32, its yield
TYX, +2.24%
at 5.18 percent, up from 5.12 percent at Monday's finish.

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